Good morning, and welcome to IPG Photonics' Fourth Quarter 2021 Conference Call. Today's call is being recorded and webcast. At this time, I would like to turn the call over to Eugene Fedotoff, IPG's Director of Investor Relations, for introductions. Please go ahead sir.

Thank you, Rob, and good morning everyone. With us today is IPG Photonics' CEO, Dr. Eugene Scherbakov; and Senior Vice President and CFO, Tim Mammen. Statements made during the course of this call that discuss management's or the company's intentions, expectations or predictions of the future are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause the company's actual results to differ materially from those projected in such forward-looking statements. These risks and uncertainties include the impact of the COVID-19 pandemic on our business and those detailed in IPG Photonics' Form 10-K for the period ended December 31, 2020 and other reports on file with the Securities and Exchange Commission. Copies of these filings may be obtained by visiting the Investors section of IPG's website or by contacting the company directly. You may also find copies on the SEC's website. Any forward-looking statements made on this call are the company's expectations or predictions as of today, February 15, 2022, only. The company assumes no obligation to publicly release any updates or revisions to any such statements. For additional details on our reported results, please refer to the earnings press release, earnings call presentation and the Excel-based financial data workbook posted on our investor relations website. We will post these prepared remarks on the investor relations website following the completion of this call. With that, I'll now turn the call over to Eugene Scherbakov.

Good morning everyone. We are pleased with our fourth quarter performance. We delivered revenue that was 8% higher than a year ago and above the top end of our guidance range. Our full-year revenue was a record, slightly above our prior record revenue reported in 2018. These strong results were driven by solid demand for our lasers in Europe, North America and improved demand in Japan, which more than offset soft demand in high power cutting applications in China. We saw increased sales in welding, high power cutting outside of China, marking, 3D printing, foil cutting, cleaning, semiconductor and a number of other products and applications that all contributed to our growth this quarter. Overall, sales outside of China grew to 69% of our total revenue, a level we have not seen in many years, showing our progress in achieving a better geographic balance in our business. Sales of high power lasers benefited from an increase in order volumes in cutting application in Europe, North America and Japan as well as strong welding revenue, which was offset by lower demand in China high power cutting market. This was due to general market softness and increased competition in the low-cost portion of this market. We continue to successfully protect our market share in the areas, which focus on reliability, technology and service. Our high power lasers and optical heads can deliver significant productivity improvements, electrical efficiency, flexibility and ease of use and integration as well as lowest total cost of ownership and global support, unmatched by other lasers and non-laser tools. At the same time, we are introducing ultra-compact rack mounted in the U series lasers with powers of up to 6 kilowatt, to be more competitive in low-cost cutting systems. We were also pleased with the growth we are seeing…

Thank you, Eugene, and good morning everyone. My comments generally will follow the earnings call presentation which is available on our investor relations website. I will start with the financial review on Slide 4. Revenue in the fourth quarter was $364 million, up 8% year-over-year driven by growth in most of our key product lines and geographies, but declined 4% sequentially mainly due to lower revenue in high power cutting applications in China. Revenue from materials processing applications increased 5% year-over-year and revenue from other applications increased 41%. Fourth quarter GAAP gross margin was 45.5%, an increase of 190 basis points year-over-year, driven by lower inventory provisions which reduced gross margin last year, but was partially offset by increased shipping costs and lower fixed cost absorption. Sequentially, gross margin decreased due to slightly higher cost of product sold, inventory provisions, shipping costs and unabsorbed manufacturing expenses. In order to offset some of the inflationary pressures we are experiencing, we have increased the selling price of some products. GAAP operating income was $85 million and operating margin was 23.3%. Net income was $65 million, or $1.21 per diluted share. The effective tax rate in the quarter was 23%. During the quarter we recognized a foreign exchange gain of $7 million primarily related to the appreciation of the U.S. Dollar versus the Euro and Russian Ruble and appreciation of Chinese Yuan. If exchange rates relative to the U.S. Dollar had been the same as one year ago, we would have expected revenue to be $3 million higher and gross profit to be $1 million higher. Moving to Slide 5. Sales of high power CW lasers decreased 19% and represented approximately 41% of total revenue. Sales of ultra-high power lasers above 6 kilowatts represented 51% of total high power CW laser sales. Pulsed…

Thank you. Our first question comes from Jim Ricchiuti with Needham & Company. Please proceed with your questions.

Hi, thank you. You may have talked about this I joined a couple of minutes late. But just with respect to the overall cutting business, it looks like it was down for the year, in around 17% high teens or so. When you talk about that market potentially stabilizing at a lower level, how do we think about that over the course of 2022? You seem to be suggesting some signs of stabilizing in China. But on the other hand, it looks like that still has the potential to be weaker in the first half of the year. How do we think about the cutting market?

So I think overall, Jim, China started last year very strong on cutting. And then as you're all aware, it was weak in the second half of the year. Order flow in January for example seem to be a little bit stronger there, they've just come back from Chinese New Year. So really, we want to see what happens in March and April, particularly the next actually three or four weeks will drive some of that total feedback that we get. But the January pointed to at least some stabilization. It was very weak in the second half of last year. The real positives, I think, on cutting now are really where some of our more focus is now in other geographies. So we are pleased with the performance in cutting in Europe, in North America, we actually saw some recovery in that market in Japan as well. So we continue to hold a very strong position outside of China. The other thing we mentioned on the script just now was that we're actually increasing the power level of the ultra compact lasers that we're offering in China. So they've been primarily at 3 kilowatts. We mentioned that very soon we're going to 6 kilowatts and even towards the end of the year to 8 kilowatts. That's a very competitive device for us there. We're not going to compete on price with it, but it will enable us to price that device because that's a lower bit of material cost a bit more competitively. And then the other side of this is the opposite end of the spectrum, the really ultra-high power lasers. We're seeing some demand there, as we mentioned in Europe for the echo lasers with higher energy efficiency. So the China cutting market remains subdued. We're pleased with performance elsewhere. And the other thing that's out there is potentially some stimulus coming into China, which the government has really been in a more contractionary phase where everybody else has been fiscally more expansionary. So that could also help to improve the turn of the business during the year.

Follow-up question is just on gross margins. Just given if we think about the year as being somewhat of a transition year with this much more modest growth rate, 3% to 6%. In the past, you've talked about a range of gross margins in the 45% to 50% area. So in light of what you're seeing in the market, is there any update you can provide with respect to how we think about gross margins?

So overall, last year, gross margins performed pretty well, right? They are in the midpoint of our range and slightly above that. Clearly, Q4 was a bit weaker. It wasn't anything specific in Q4. It’s a number of different things that we called out, product cost a little bit with mix. There's some inflationary pressures there, shipping cost, a little bit lower absorption. Overall though, given a relatively slower start to the year and that guide for the year of 3% to 6% that actually requires revenue to pick up meaningfully in Q2, Q3 and Q4, that's the first benefit we'll get on gross margin as we tend towards a higher – slightly higher revenue level. And then in addition to that, I mentioned that we've started to increase the price of certain products. We're also focused on continuing to reduce the internal cost of components that the 3 kilowatt ultra compact moving to 6 kilowatt and 8 kilowatt is an example of some of the cost initiatives there. So overall, as we get to a slightly higher revenue level in the second half of the – not the second half of Q2 and the second half of the year, expect to see some return to that upper half of our gross margin range. We're not stepping away from that, target of getting into that more consistently into that half of that range, Jim.

Okay, thank you.

Welcome.

And also such kind of margin today is IPG. IPG definitely is a leader in this industry. Nobody can reach such kind of results.

Our next question comes from Patrick Ho with Stifel. Please proceed with your questions.

Thank you very much. Tim, maybe just as a follow-up to some of the comments you just made about gross margins. The supply chain and you talked about shipping costs being higher. Were there any challenges in procuring parts or were they just more that you had to pay more for those parts because the revenues look pretty good for December. What are some of the supply chain challenges that you're experiencing today?

Of course, there will be some challenges, first of all, but taken in mind that IPG is a vertically integrated company. The main important components for our lasers we're producing ourself inside the company, this means it's not any prominence to supply in time and we also get good optimal cost for these components. We are talking about some components which are receiving from outside. Of course, there is some first one is test level, price for some components increased dramatically by the way electronic components, for example, chips in some cases, price increase up to three times up to 10 times. Of course, it also influences our gross margin, also shipping cost additional, yes, definitely. And the raw materials, some metals also branch for this metal growth dramatic capital 20%, 25%, 30%. Of course, it's influenced on our gross margin, but we are also working to optimization every way. Every time we are talking about this, we are making this optimization is why we would like to keep our margin high enough.

Great. That's helpful. And maybe as my follow-up question this diversification strategy that you're taking on and obviously trying to accelerate. As we look at 2022 as a whole, given that you have new products and new markets, and also the regional expansion, where do you believe the greatest, I guess, traction you'll get among markets, products or regions, where is that diversification going to greatly contribute to at least 2022 this year?

I think the main – our contribution will be definitely from the United States and also from Europe, a different kind of application, including cutting market, it's definitely, but also our medical business going good enough. And also, we see a good opportunity first of all in the United States and Europe. And also, there is some new products which we start to introduce now to the market. And our main advantage for this year will be that we will not concentrate on cutting only market in China. We will concentrate our different applications for different regions.

Great. Thank you.

Our next question comes from Nick Todorov with Longbow Research. Please proceed with your questions.

Yes, thanks and good morning everyone. I want to first double-click on China. Is there any change in the strategy going forward? It sounds to me that you're going to be even more selective in participating in deals and maybe you're seeing an incremental uptick in competition? I know competition has been formidable there for a while, but maybe the pricing aggression is penetrating into the ultra-high power space. Can you give us a little bit of an update on the China strategy?

China strategy is very simple. Of course, we are not pulling this price to reach produced our competitors in China price strategy. In some cases, it's not a financial basis for this. It's definitely they would like to get some shares in this market, as a result any consideration on gross margin or profitability. Our strategy is very simple. We are producing the best product with high quality, with high efficiency. In this case, we can keep ourselves – premium price for our product. It's resulting a problem, I mean for standard product. High-power wages, I mean, is power more than 15 kilowatt, 20 kilowatt, 30 kilowatt and 40 kilowatt, definitely, IPG is leader, and we also can keep a good enough price for this product. By the way, the first echo – first order for echo lasers, 20 kilowatt echo lasers also we see for China. Of course, there's also some demand in Europe and in the United States, but first of all in China. And also for us a good opportunity because nobody can supply such finest laser such finest parameter like 50% local also compact, it’s different. I'm not talking about this on the high power also pulsed laser, of course, a portion of this market. And high-power pulsed lasers, which are using for foil cutting and other applications. Green lasers, there is – there are lot of opportunities also to compete and to keep our part on the Chinese market.

Okay. And as a follow-up, as you embark on this diversification strategy, how are you thinking about M&A? Traditionally, you've done some smaller tuck-in deals. How are you thinking about potential larger deals maybe to accelerate the diversification plans?

Definitely, I have discussed about this the recent opportunity, but we are very suspicious about it. Because one of the big problem is not only to take some company, the main problem is integrate. And this is why we are looking for every time or for the new technologies, which will be also added to our technology portfolio or the companies which can be easily integrated to our manufacturing process and also to integrate to our management system. This is our strategy for M&A.

Okay. Last quick follow-up, just Tim, last year, I think you said EV sales were, I think, 9% of sales. Can you share an update how much EV related sales were for 2021 as a whole?

I don't think we gave a specific number there. I mean EV sales can range from like 5% to slightly above 10% each quarter. And we haven't gone into more detail than that. So they were a meaningful contributor across also pulse A and B, single-mode kilowatt-scale lasers, even LDD, so overall for the year, probably slightly above 10%. Nick, one thing I want to draw your attention to is like your comment about embarking on this diversification strategy. The company has been pursuing this diversification strategy for several years now, right? We introduced LightWELD over a year ago. We introduced higher-power pulsed lasers, AMB lasers, the QCL lasers for spot welding accessories. The green laser has been in the market for a long period of time. We actually find ourselves having embarked on that strategy some time ago, better positioned now than we would otherwise have been. There's a lot of work that's already gone on to that, and we now want to really accelerate that and remain committed not to just being drawn into a price war on certain parts of the China market. Even in China, there's a lot of diversity in revenue last year compared to 2020 or even 2019.

Yes. Tim, I agree. I think the acceleration of that strategy is a more fair description. Thanks, appreciate it.

Our next question is from Michael Feniger with Bank of America. Please proceed with your questions.

Hey, gentlemen. Thanks for taking my call. Can you touch on this, earlier I recognize this is a fluid situation with geopolitical tension. In a scenario where Russia has kicked out at Swift, what does that mean exactly? And can you flesh out a little bit more your plans to build contingencies right now? What does that entail exactly?

So first of all, I'm not a banking expert, right? I mean, we kick out at Swift is actually, I don't think on the cards because they talked about Swift in 2014, and there's been a lot of pushback against that. There's probably like targeted sanctions against Russian banks, which would mean that you'd be limited in your ability to receive or pay cash out there. We also have international bank accounts in Russia. As around sanctions and the other areas, anything that we talk about at the moment is very speculative because there's a wide range of potential things that could happen. And a lot of what's been talked about in terms of sanctions doesn't target a lot of our optical components may target some of them. It depends whether they’re retaliatory sanctions imposed or not by Russia. But at the moment, it’s a very fluid situation. So – and there’s more positive, I think this morning even than it was at the end of last week. And we have obviously been looking closely at it and trying to mitigate those risks by putting inventory in different locations and also in the medium to longer term, looking at how to reduce some of those risks a bit more.

And just following up on that, Tim, you mentioned how – I think the inventories, your inventory levels were up sequentially, yet I think sales were down a little bit sequentially. The inventory to sales ratio kind of jumped. How are we thinking about your inventory levels kind of going forward? Is there a specific region you guys are charging there of those inventories build right now?

So there’s a lot of focus on inventory now. I mean there’s some – habitually, there’s some things the way that inventory was managed historically within the company that had a lot of positives. So for example, right now, when we talk about some of the risks, whether it’s supply chain or geopolitical risk, some of the increases in Q4 relate to increasing inventory in different locations. Some of it relates to significant increase in electronic components, right? So you’re kind of going to parse this out a little bit between some of the strategic things we’ve done around inventory that mitigate risks and enable us to maintain lead times to customers. And then also the fact that the company really is starting to look more holistically around inventory planning and management and targeting that is an area where we want to improve execution, improve the processes in different areas. But at the moment, there’s puts and takes around it. But our overall target this year, and I don’t want to talk about this on a quarterly basis, but would be to try and stabilize inventory at the absolute level it’s at, which would mean that we’re not consuming cash on it and maybe even take a little bit of cash out of it. But we’re not intending to certainly grow it from the level it’s at, at the moment. There’s a lot of strategic inventory on hand.

Interesting. And just lastly, I know there’s a lot of focus on the 2022 with the revenue growth range of 3% to 6%. How much do you think we’re embedding costs going up in 2022? Is it going a similar amount of that revenue growth? Should we think about is it slightly below that revenue growth figure? Just curious on what you’re seeing on the inflationary cost side and how to think about that as we go through 2022. Thanks everyone.

Yes, there’s cost on like the sort of material side that Dr. Scherbakov talked about, but we’ve also got – continue to have initiatives where, for example, if you get more power out of an individual component, the cost per unit of power goes down a bit. On the other side of it, for example, last year, we actually had a record year, right, and very strong revenue. So we had some of our variable compensation levels were higher last year. Those will probably go down, not probably, they will go down at the budgeted level of revenue. And that would be a benefit, both – more on the operating expense side, that variable comp, a little bit on the manufacturing side. Looking really at aligning and managing capacity on the manufacturing side and making sure you’re absorbing costs would be a benefit that may offset some of the inflationary pressures. So it’s – even with merit increases at a higher rate expected this year than they are historically, right? Historically, you can budget a sort of 3% increase this year, your some regions at a higher – significantly higher level than that and on average 4% to 5%. There are some benefits to the operating expense side that leave me with some degree that would actually create a total, for example, expense forecast relative to our revenue budget shows a little bit of leverage in it.

Thank you. Thanks everyone.

Our next question is from Tom Diffely with D.A. Davidson. Please proceed with your question.

Yes, good. Thank you for the questions today. Tim, I was wondering if there’s some way to quantify the impact of Russia, maybe the percentage of bill of materials that are sourced out of Russia or something along those lines.

Just at a high level, those 2,000-plus employees in Russia they provide a significant amount of components. They sell some of our lower-cost lasers and make them for China there. The headcount, if you approximate it is 1/3 of total head count that we have. And it’s more on the component side of things, optical, the higher labor content optical components. But those are also the components that we think are pretty unlikely to be impacted by sanctions. Some of the work we’ve done on that, particularly from the U.S. and euro side – European side indicates that those basic optical components wouldn’t be part of any sanctioned in any event, they’re coming from Russia to our other manufacturing operations.

Okay. That’s very helpful. Thank you, Tim. And then a follow-up question on China. How much is the softness that you’re seeing today is driven by just kind of depressed end market demand versus than kind of a recently intensified pricing environment?

The country market is both a combination of weaker demand as well as this. We’re stepping or not stepping away. We haven’t competed on price in China for two years. So particularly at the higher end of that market for automated investments may be a little bit weaker. Certainly, China has not been stimulating. They’ve even a more contractionary phase. So it’s a combination of probably a weaker macro environment, definitely, some COVID impact. And then the pricing competition that continues to be aggressive from the main manufacturers there.

Okay, well, thanks Tim. I appreciate your time.

Our next question comes from Paretosh Misra with Berenberg. Please proceed with your question.

Hi, everyone. First, on your EV business. Any color you could provide as to what you’re hearing from your customers on battery capacity build out this year. Do you expect incremental capacity built this year to be same as last year or maybe higher? I’m guessing last year, you probably had at 200 to 300 gigawatt hours of incremental capacity or demand. So just any color you could provide for this year? That would be my question number one.

When you look at the data out there around battery capacity, it basically kind of stabilizes in that 200 to 300 gigawatt capacity each year, but it goes on being sustained for a multiyear period, right? This is a decade-long investment cycle. What we would see within that and would hope to benefit from is, for example, an increased diversity of applications, whether they be increase in cleaning applications. Perhaps more welding done benefiting also, not just from the battery side of it but from increase in electric motor manufacturing and then as investments happen on white increases in laser demand from that. So all of the data you kind of look at doesn’t say that battery capacity sort of jumps from 300 to 600 gigawatts a year in investment but it is a sustainable long-term source of revenue for the industry.

Got it. And then can you also discuss your backlog? I think firm went up by a lot, but the frame agreements declined. So what’s going on there?

A lot of frame agreements come in China for the cutting applications. So sometimes it’s timing of that, but given the weakness in that end market, that would be an explanation for that. In addition, our total backlog in China is still quite strong. So we actually have quite a lot of orders on hand for cutting, which we’re waiting to see when they get called off. And if that market continues to stabilize or even demand improves a little bit, you’d expect to see those orders called up. So there isn’t a pressing need for new cutting orders. We’ve got – it’s more a question of them being called off. The other component of backlog, I think, if you look at the shippable backlog, that’s up meaningfully year-over-year, which again is a positive trend. Some of that is driven by some of the changes in the business. So for example, we have a lot of visibility into the medical where not just for systems but consumable fibers. We actually have from some of our semiconductor customers, orders on hand that go out even for the full year and potentially even I think even into early 2023. So that would be an emerging business line, the systems business, which is showing some recovery. We’ve got a very strong backlog for medical device systems where the lead times are a lot longer. And then the other thing that I think is influencing backlog a little bit, that’s giving us a bit more than the normal three-month trajectory into visibility is that given some of the supply chain issues we are getting orders from customers in Europe and North America with slightly more visibility or longer lead times because they want to make sure that they’re getting allocated production. So there’s sort of a number of different components of the makeup of backlog that have changed a little bit.

Got it. Thanks for the color. And maybe just the last one. On your share repurchase plan, is there a time horizon over which you’re looking to execute this? Just wondering if there might be some opportunity for some sort of accelerated buyback.

We’ve not done ASRs before. We look at this more on the opportunistic basis. So depending upon where the stock is trading relative to our internal assessment of fair value you’d see more shares repurchased. There is no specific time line related to the new repurchase that’s been announced. But the last two quarters, I think you’ve seen some good level of repurchasing going on last quarter was almost $60 million. So that maybe gives you a time frame over which that may get done.

Thanks, Time. Thanks so much.

Our next question comes from Jamie Wang with Citigroup. Please proceed with your question.

Thank you for taking my questions. Just a quick one. If I heard you correctly, you mentioned about the green laser demand for solar industry was also weak. So I was wondering, is that because of the industry growth slow down? Or the competition in the sector was it getting more intensified. Thank you.

I mentioned in our presentation that this market is cycling. That is why maybe it’s not too big – we don’t have a big enough orders to this year. But definitely, it will grow because demand for solar in China and the United States will definitely increase. We anticipated that our green lasers will be used definitely for this market, but not only for solar applications.

Yes. It’s not a competitive issue. It’s the cyclical demand side of Jamie.

Okay. Maybe just a quick follow-up, sorry, the quick second question from me. Is it possible to share with us the gross margin differences between China and non-China? Because I found that after 2019 the revenue contribution from China has somehow negatively correlated with the Europe gross margin trend. So I was wondering if there less revenue contributing from China, is that really good for your margin. Yes, thanks.

This is not – we don’t give that granularity around it. I mean what we’ve said is that we’re not competing on price in China. Certainly, when you look at like ultra high-power laser sales, whether they’re in China or elsewhere, they have very, very strong margin profile, the pulsed lasers, high-power pulsed laser very strong margin profile. So we don’t – well, first of all, we don’t break it out, but we’ve also said that we’re really selling on the value proposition that we deliver for the product.

No more questions from me. Thank you. Thank you very much.

Thank you.

Our next question is from Mark Miller with The Benchmark Company. Please proceed with your question.

Thank you for the question. You talked about green lasers, but what are the other drivers in terms of emerging product sales?

Strong drivers in that are things like the high-power pulsed for foil cutting applications as well as cleaning applications and other ablative processes, the AMB laser for welding applications. The new LightWELD products which is the handheld welding application that displaces traditional make and tick and brings numerous advantages to that process, including speed, quality of weld, ability to incorporate cleaning functions within it. Obviously, the green, the ultrafast pulsed, which we expect to start to more meaningfully contribute this year, some of the beam delivery applications. So whether it’s weld monitoring or high-speed scanners, cutting heads and welding heads that get delivered with the lasers. Those would be the main – and medical – sorry, I left out a medical application for urology, the surgical medical application.

But I would like also to add some systems for EV application, which we already stepped to supply this year. And we have a strong backlog for this system for this year. And I think it would give us a good opportunity to produce and to supply to our customer, not only components like lasers and vertical and LDD monitoring, but integrated systems, subsystems for EV applications first of all.

Just wondering, are any of your major customers experiencing component shortage? And is that impacting their business to you?

Customers experience components shortage. So – yes, I think some of the people on the cutting side have seen shortages of linear motors and drives and electronic components. I mean everybody is subject to the chip and electronic component supply chain issues that are affecting many different industries, and that would be the main area that you’ve heard about.

But it’s on a feel because, as usual, our OEM customer for cutting application, for example, no, they don’t have any big problems as this.

Thank you.

We have reached the end of the question-and-answer session. I will now turn the call over to Eugene Fedotoff for closing comments.

Thank you, everyone, for joining us this morning and for your continued interest in IPG. We will be participating in a number of investor events this quarter, and looking forward to speaking with you over the coming weeks. Have a great day, everyone.

This concludes today’s conference. You may disconnect your lines at this time, and we thank you for your participation.